1. The Great Depression The United States Experience 1929-1941

2. What Caused the Great Depression? Why was aggregate demand so low? Is there evidence to support monetary impotence or evidence of a failure of the economy to self correct? Did the aggregate supply curve shift down and to the right, permitting the economy to self correct? Were nominal wages rigid and did real wages fluctuate procyclically or countercyclically?

3. Data Year MS Real MS Real Y Real I Y/Y N PI UR r Avg Hourly Avg Real Hr ($, b) ($, b, 1929 prices) % % % Earnings ($) Earnings ($) 1929 26.0 26.0 103.7 14.9 102.8 100 3.2 3.6 0.563 0.563 1930 25.2 26.1 94.8 11.4 90.8 96.3 8.9 3.3 0.560 0.581 1931 23.5 26.7 88.7 8.0 82.1 86.3 16.3 3.3 0.532 0.605 1932 20.6 25.5 77.2 4.5 69.0 76.2 24.1 3.7 0.485 0.600 1933 19.4 24.4 76.1 3.9 65.7 74.1 25.2 3.3 0.457 0.575 1934 21.4 26.0 84.3 5.2 70.4 78.3 22.0 3.1 0.512 0.623 1935 25.3 30.4 91.9 6.7 74.1 79.8 20.3 2.8 0.524 0.630 1936 28.8 34.4 103.7 8.9 80.8 80.7 17.0 2.7 0.534 0.637 1937 30.2 35.0 109.2 11.0 82.2 84.2 14.3 2.7 0.566 0.656 1938 29.8 35.3 105.4 9.1 76.7 81.7 19.1 2.6 0.576 0.681 1939 33.4 39.8 114.0 10.9 80.1 80.7 17.2 2.4 0.583 0.695 1940 38.8 45.8 123.7 13.2 84.0 81.9 14.6 2.2 0.597 0.705 1941 45.4 51.1 144.9 15.5 95.0 87.4 9.9 2.0 0.655 0.737

4. Weak Aggregate Demand According to the data, the primary initial cause of the Great Depression was a decrease in investment spending. –Real fixed investment fell by 74% from $14.9 billion in 1929 prices in 1929 to $3.9 billion in 1933. –By 1939, real fixed investment was still 27% below the 1929 level despite a 53% increase in the money supply.

5. Weak Aggregate Demand According to the IS/LM interpretation of events in the 1930s, the IS curve shifted to the left while the LM curve shifted to the right. The failure of investment to recover is consistent with either a vertical IS curve or a horizontal LM curve. Which is right?

6. IS/LM Model LM 4 LM 3 LM 2 LM 1 IS 0 0 r r Y 1 Y N Y r2r2 r3r3 r4r4 r1r1 Vertical IS Curve IS Horizontal LM Curve LM r1r1

7. Vertical IS? Horizontal LM? The IS curve is vertical (or nearly vertical) when a decline in interest rates fails to stimulate new investment spending. –From 1934 to 1940, the interest rate declined from 3.1% to 2.2% while investment spending increased from $5.2 billion to $13.2 billion. –Apparently, the IS curve was not vertical.

8. Vertical IS? Horizontal LM? The LM curve is horizontal when an increase in the money supply fails to reduce interest rates. –From 1934 to 1940, the real money supply increased from $26.0 billion to $45.8 billion while interest rates fell from 3.1% to 2.2%. –Apparently, the LM curve was not horizontal.

9. Monetary vs. Non-monetary Factors Gordon and Wilcox determined that both monetary and non-monetary factors contributed to the depression, but at different times. –From 1929 to 1931, the drop in the money supply was not sufficient to cause the collapse of GDP. –The collapse must be explained by the loss of wealth in the stock market and the overbuilding that occurred during the 1920s. –But after 1931, the contraction was caused mainly by monetary factors, particularly the failure of the banking system.

10. Prices and the Output Ratio Does the behavior of output and the price level support the Keynesian assumption of rigid nominal wages or the classical interpretation of a self-correcting economy? –If the classical story is correct, then decreases in the price level should cause the economy to return to full employment. –If the Keynesian story is correct, then the failure of nominal wages to fall should hamper the recovery.

11. Self Correction? The story of the Great Depression appears to lie in shifts of the aggregate demand curve to the left and then over time to the right. There is no evidence of a shift in the aggregate supply curve to the right as the price level fell. –Between 1936 and 1940, there was no deflation despite the fact that Y/Y N was at or below 86%.

12. The Price Level and Y/Y N 50 60 70 80 90 100 110 0 0 P P P LAS Y/Y N AD 1933 AD 1929 100 75 100 75 1929 1933 1941 1940 1939 1934 1932 1931 1930 1938 AD 1941 1937 Gordon, p. 222

13. Behavior of Nominal Wage Rates Why did the aggregate supply curve fail to shift? –A fixed AS curve requires a rigid nominal wage. Between 1929 and 1930 when real GDP fell by 9%, nominal wages did not decline at all. Nominal wages fell between 1931 and 1933, but rose again by 12% in 1934 when unemployment was 22%. By 1937, nominal wages equaled those of 1929 despite an unemployment rate of 14%. –Nominal wages were not rigid, but they did not fall continuously after 1933 so were not part of a self correction mechanism.

14. Behavior of Real Wage Rates The real wage rose after 1933 despite high levels of unemployment. This is attributed to government intervention. –During 1934 and 1935, the National Industrial Recovery Act (NIRA) attempted to raise wages and prices by instituting industry-specific codes that required employers to raise wage rates. –The NIRA was declared unconstitutional in 1935, and was succeeded by the Wagner Act, which encouraged union membership.

15. Data Year MS Real MS Real Y Real I Y/Y N PI UR r Avg Hr Earn Avg Real Hr ($, b) ($, b, 1929 prices) % % % Earnings ($) Earnings ($) 1929 26.0 26.0 103.7 14.9 102.8 100 3.2 3.6 0.563 0.563 1930 25.2 26.1 94.8 11.4 90.8 96.3 8.9 3.3 0.560 0.581 1931 23.5 26.7 88.7 8.0 82.1 86.3 16.3 3.3 0.532 0.605 1932 20.6 25.5 77.2 4.5 69.0 76.2 24.1 3.7 0.485 0.600 1933 19.4 24.4 76.1 3.9 65.7 74.1 25.2 3.3 0.457 0.575 1934 21.4 26.0 84.3 5.2 70.4 78.3 22.0 3.1 0.512 0.623 1935 25.3 30.4 91.9 6.7 74.1 79.8 20.3 2.8 0.524 0.630 1936 28.8 34.4 103.7 8.9 80.8 80.7 17.0 2.7 0.534 0.637 1937 30.2 35.0 109.2 11.0 82.2 84.2 14.3 2.7 0.566 0.656 1938 29.8 35.3 105.4 9.1 76.7 81.7 19.1 2.6 0.576 0.681 1939 33.4 39.8 114.0 10.9 80.1 80.7 17.2 2.4 0.583 0.695 1940 38.8 45.8 123.7 13.2 84.0 81.9 14.6 2.2 0.597 0.705 1941 45.4 51.1 144.9 15.5 95.0 87.4 9.9 2.0 0.655 0.737